The History of Recoveries

This recovery's strength may surprise you.

The current Great Recession, as some call it, has destroyed confidence as much as it has jobs and wealth. From our peak, inflation-adjusted GDP has fallen by 3.9%. The mild downturns of 1990-91 and 2001, each just eight months long, brought losses to the real GDP of just 1.4% and 0.3%, respectively.

The recession that sunk its hooks into the U.S. economy in the fourth quarter of 2007 has set records in vital categories such as manufacturing and trade inventories (the steepest decline since 1949), capacity utilization (lowest since at least 1967) and industrial production (sharpest fall since 1946).

History tells us, the deeper the slump, the stronger the recovery. A well-regarded economist recently said that the most important determining factor of the strength of a recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-39 period.

Growth snapped back following the downturns of 1893-94, 1907-08, 1920-21, and 1929-33. At the trough in 1933, the unemployment rate stood at 25%. (If there had been a measure of labor underutilization back then, it likely would have been about 44%, compared to 16.8% today.)

At the same time, the consumption share of GDP was above 80% in 1933, and the household savings rate was negative. Yet, in the four years that followed, the economy expanded at a 9.5% annual average rate, while the unemployment rate dropped 10.6 percentage points.

Our recession does bear comparison with the slump of 1981-82. In the worst quarter of that contraction, (the first quarter of 1982), real GDP shrank at an annual rate of 6.4%, matching the steepest drop of the current recession (the first quarter of 2009). Yet the recovery, starting in the first quarter of 1983, experienced quarterly growth rates (expressed as annual rates of change) over the next six quarters of 5.1%, 9.3%, 8.1%, 8.5%, 8.0%, and 7.1%. Not until the third quarter of 1984 did real quarterly GDP growth drop below 5%.

High unemployment

The 10.2% unemployment rate for October is a grim reminder of how steep the fall has been and it will undoubtedly rise further, even though the economy has returned to positive GDP growth (3.5% in the third quarter). But falling employment always lags a recovery. When the early 1980s recession ended in December 1982, unemployment was at 10.8%; it didn't fall below 6% until September 1987.

Remember, in the Great Depression, falling prices opened wallets. Finding bargains in homes, stocks, and many other goods and services, consumers and investors snapped them up, a truism we are witnessing in the housing market today. The Economic Cycle Research Institute's long-leading index of the U.S. economy, along with supporting sub-indices, are making 26-year highs and point to the strongest bounce-back since 1983.

The last time a recession ravaged the labor market as badly as this one, which was 1957-58, payrolls then climbed by a hefty 4.5% in the first year of an ensuing 24-month expansion. Of course, there is no assurance that growth this time will match that pace, only that growth is likely to surprise us by its strength, not its weakness.

I found a great quote from the English economist Arthur C. Pigou which speaks volumes: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism.”